2014-05-24

Real Estate: Buying vs. Renting

Buying a house is a critical component in the American success narrative... which should automatically make you suspicious.

If homeownership is nothing else, it's popular. Through all of the economic gyrations of the past 50 years, ownership rates have consistently stayed within a few points of 65%:


Does the omnipresent "housing is a great investment" advice jive with reality?
Let's look at some numbers.


History


Housing has gotten more expensive, even after you adjust for inflation:



As I've mentioned previously, housing costs now account for a third of the average household's expenditures:


What else is happening to the average household? It's getting smaller:



While the average house is getting bigger:



Which is leaving each member of that shrinking average household with MUCH more space:



When you normalize by home size, the price of a house per square foot has actually remained constant:



This begs the question: are homes today more expensive because the value of real estate has risen, or just because new homes today are 2.35x larger than they were in 1950?

(And what the heck are people doing with all of that extra space? Why, they're filling it with junk and renting a storage unit besides!)


Don't Forget Opportunity Cost


"Buying is great: once you pay off the mortgage, you don't have to pay anything!"


This may be true if you live in a cave, but real houses come with maintenance, property tax, and insurance costs that erode your returns. Worse yet: real estate values have never kept pace with the stock market over the long term. Once you take into account the opportunity cost of buying a home instead of investing elsewhere, the graph looks markedly different:



Not so clear-cut anymore!

This graph also takes into account the quantitative effects of another nasty feature of real estate: transaction costs on the order of 5-6% that the seller is responsible for covering.  I'm definitely not the first person to question the investment value of a home: this Thursday is the one-year anniversary of an excellent article by Jim Collins on this topic.  (There are ways around this!  Just ask Mr. Money Mustache—if you happen to know someone with a real estate license, this gigantic transaction cost can be made to disappear).

These graphs only reflect the lifetime costs associated with a single set of parameters. Make your own copy of my spreadsheet and try some different numbers.  The New York Times published a similar buy-vs-rent calculator in 2014.


The Point I Mean To Make


In a purely quantitative sense, either option can come out ahead depending on your circumstances.  Real estate can have a place in a well-thought-out portfolio, but the emphasis here is on the thinking: don't assume a house is a good investment for you, and don't assume that buying a house is something that you inevitably must do.  Housing is a very expensive category, which means that this is where you have the opportunity to save the big money.

"You pays your money and you takes your choice."  Do the math and consciously acknowledge what your decisions are going to cost you in the long-term.

How do buying and renting compare qualitatively, from a quality-of-life perspective?  How about philosophically?

Renting has a lot going for it, which I'll expand upon in a future article.